Justin Fox: Why the Fed Is So Wimpy: “Regulatory capture…

…is a phenomenon that economists, political scientists, and legal scholars have been writing about for decades…. Actually witnessing capture in the wild is different, though, and the new This American Life episode with secret recordings of bank examiners at the Federal Reserve Bank of New York going about their jobs is going to focus a lot more attention on the phenomenon. It’s really well done, and you should listen to it, read the transcript, and/or read the story by ProPublica reporter Jake Bernstein…. Segarra pushed for a tough Fed line on Goldman’s lack of a substantive conflict of interest policy, and was rebuffed by her boss. This is a big deal, and for much more than the legal/compliance reasons discussed in the piece. That’s because, for the past two decades or so, not having a substantive conflict of interest policy has been Goldman’s business model…. All this is meant not to excuse the extreme timidity apparent in the Fed tapes, but to explain why it’s been so hard for the New York Fed to adopt the more aggressive, questioning approach… Maybe if banking laws and regulations were simpler and more straightforward, the bank examiners at the Fed and elsewhere wouldn’t so often be in the position of making judgment calls that favor the banks they oversee. Then again, the people who write banking laws and regulations are not exactly immune from capture themselves. This won’t be an easy thing to fix.

Paul Krugman: Those Lazy Jobless – NYTimes.com Last week John Boehner, the speaker of the House, explained…

…People, he said, have “this idea” that “I really don’t have to work. I don’t really want to do this. I think I’d rather just sit around.” Holy 47 percent, Batman! It’s hardly the first time a prominent conservative has said something along these lines…. But it’s still amazing — and revealing — to hear this line being repeated now. For the blame-the-victim crowd has gotten everything it wanted: Benefits, especially for the long-term unemployed, have been slashed or eliminated. So now we have rants against the bums on welfare when they aren’t bums — they never were — and there’s no welfare. Why? First things first: I don’t know how many people realize just how successful the campaign against any kind of relief for those who can’t find jobs has been. But it’s a striking picture…. The total value of unemployment benefits is less than 0.25 percent of G.D.P., half what it was in 2003, when the unemployment rate was roughly the same as it is now…. Strange to say, this outbreak of anti-compassionate conservatism hasn’t produced a job surge…. Why is there so much animus against the unemployed, such a strong conviction that they’re getting away with something, at a time when they’re actually being treated with unprecedented harshness?…

Self-righteous cruelty toward the victims of disaster, especially when the disaster goes on for an extended period, is common in history. Still, Republicans haven’t always been like this…. Is it race? That’s always a hypothesis worth considering…. It’s true that most of the unemployed are white…. But conservatives may not know this, treating the unemployed as part of a vaguely defined, dark-skinned crowd of “takers.” My guess, however, is that it’s mainly about the closed information loop of the modern right…. Boehner was clearly saying what he and everyone around him really thinks, what they say to each other when they don’t expect others to hear…

Heather Cox Richardson: How the GOP stopped caring about you: “By the time the [Civil] War ended…

…the GOP had invented national banking, currency, and taxation; had provided schools and homes for poor Americans; and had freed the country’s 4  million slaves. A half-century later…Theodore Roosevelt fulminated against that “small class of enormously wealthy and economically powerful men, whose chief object is to hold and increase their power.” Insisting that America must return to “an economic system under which each man shall be guaranteed the opportunity to show the best that there is in him,” the Republican president called for government to regulate business, prohibit corporate funding of political campaigns, and impose income and inheritance taxes. In the mid-20th century, Republican President Dwight Eisenhower recoiled from using American resources to build weapons alone….

At these crucial moments, Republican leaders argued that economic opportunity is central to the American ideal and that government must enable all to rise. But… it has sparked a backlash from within, prompting the GOP to throw its support behind America’s wealthiest people and to blame those who fall behind for their own poverty. How did the progressive Republican Party of Lincoln, Roosevelt and Eisenhower become the reactionary party of Ronald Reagan, the tea party and Paul Ryan?…

Civil War Republicans rejected the idea that they were enacting welfare legislation. Rather, they argued, it was a legitimate use of the government to promote broad-based economic growth. The Founding Fathers had neglected to guard against the wealthy dominating and subverting the government, but Lincoln’s Republican Party addressed that omission. Almost as soon as the Civil War ended, the Republicans’ egalitarian vision came under attack…. Eastern Republicans, whose industries flourished under the party’s economic policies, began to focus on protecting their interests rather than promoting opportunity…. In the 1880s, voters turned to the Democrats, and the Republican Party restricted voting and jiggered the electoral system to stay in power, adding six states to the Union in an attempt to stack the Senate…. In three decades, the Republican Party had taken the nation to opposite extremes. Once the driving agents of economic opportunity, Republicans had become the engineers of economic ruin.

As Lincoln had done before him, Theodore Roosevelt recognized the danger of a system that concentrated wealth and power. He came of age during the 1880s…. He called for government regulation of business and promotion of education to guarantee a level playing field, and he forced national leaders again to take measures to protect economic opportunity…. The backlash against this second expansion of the middle class was quick and dramatic, especially amid the labor and racial unrest following World War I. Republicans accused workers and African Americans of plotting to bring the Bolshevik revolution to America, and demanded support for unbridled capitalism from all Americans…. Like 30 years before, wealth became concentrated at the top….

At the end of World War II, the Republican cycle began once more. Dwight Eisenhower renewed the effort to expand the middle class, adapting that vision to the modern era. Facing the challenge of leading a superpower in a divided nuclear world, he fervently believed that America had to promote economic prosperity across the globe to prevent the political and religious extremism that sparked wars. Like Lincoln and Roosevelt before him, Eisenhower adhered to the classic Republican view of government and set out to use it to guarantee economic opportunity in the postwar world…. But business leaders who hated government regulation insisted that Eisenhower’s policies were tantamount to communism. They pointed to desegregation as proof that the government was redistributing tax dollars to undeserving minorities, and their mingling of racism and communist fears won votes. By the 1970s, in an uncanny echo of the 1890s and the 1920s, Republican economists had embraced the old idea that only deregulation and unfettered capitalism would create wealth, which would then trickle down to everyone…. In the early 21st century, the U.S. economy, after years of Republican control, looked much like that of the American South before the Civil War. Business and wealth were entrenched in the nation’s political and judicial system, while most Americans found themselves burdened with debt and stagnating incomes….

The history of the Republican Party shows why, since the Civil War, the nation has been caught in cycles of progressivism and reaction. Is it possible for the party — and the country — to resolve this tension? Surely the original Republican argument that economic opportunity must be advanced by an active government, the idea conceived by Lincoln and adopted by Roosevelt and Eisenhower, could work in the modern global economy as it did in the era of industrialization and in the nuclear age. But can the party shed the opposing argument, developed in the conflicts of the late 19th century and recycled ever since, that government activism is tantamount to socialism?

About half of the decline in labor force participation since 2007 is due to well-identified demographic trends plus extrapolated age and gender specific trends. About one-sixth of the decrease comes from the well-established fact that when the unemployment rate is elevated labor force participation declines. But how much comes from the fact that the downturn and jobless recovery were not only deep but long? We do not know, because we have never seen anything nearly as deep and long before. The cyclicalists say that there is a strong presumption that a deep and long employment downturn casts a strong shadow on participation, and are agnostic about whether and how rapidly participation would pick up in a high-pressure economy. The structuralists say that the decline would not be reversed in a high-pressure economy, but do not claim to have any insight into why the excess decline in participation occurred.

Nick Bunker: Labor Market Slack: “There are two major reasons behind the decline in participation…

…the Great Recession… the aging of the Baby Boomer generation…. Obama’s Council of Economic Advisers… found that aging accounts for about half of the decrease since the last quarter of 2007… one-sixth of the decline… from [normal] cyclical factors… one-third of the decline comes from ‘other factors’…. Janet Yellen is keening aware of the lack of stark divide between cyclical and structural labor market factors…. Policymakers, while not sailing blind, are still in a considerable amount of fog.

It is very interesting: to overturn Chevron vs. NRDC would instantly require the substantial rewriting of every single administrative law textbook in the United States, and reopen a substantial proportion of administrative law cases adjudicated since 1984, plus all administrative determinations made under the shadow of the Chevron Doctrine. Five justices could do a Bush v. Gore–claim that this decision is sui generis and not a precedent for anything. But that is embarrassing enough that it is hard to imagine that Roberts, Scalia, Alito, Thomas, and Kennedy would do that for anything less than the presidency. But it is also hard to believe that Roberts, Scalia, Alito, Thomas, and Kennedy would make a hash of administrative law doctrine. And it is equally hard to believe that any of the Five Horsemen would want to alienate their patrons in the Republican Party further.

The only way out, I think, is for the Five Horsemen to take refuge in delay and demand that the plaintiffs bring them a split among the circuits before they take the case. But the very smart Robert Litan has long thought that Halbig has legs, and wrote something at http://bloomberg.gov a while ago predicting it would go 5-4 at the Supreme Court–and that the health exchanges in the red states would then go into adverse-selection meltdown…

Sahil Kapur: Why This Conservative Lawyer Thinks He Can Still Cripple Obamacare: “The top lawyer arguing a case to overturn Obamacare subsidies…

…believes he can succeed at crippling the law even if it’s upheld in every district and appellate court…. Michael Carvin… expects the justices to view an expected D.C. Circuit ruling in favor of the law as corrupted by politics and agree to review it. ‘I don’t know that four justices, who are needed to [take the case] here, are going to give much of a damn about what a bunch of Obama appointees on the D.C. Circuit think…. This is a hugely important case…. I’m not going to lose any Republican-appointed judges’ votes on the en banc — then I think the calculus would be, well let’s take it now and get it resolved.’ And if the case reaches the Supreme Court, Carvin expects all five Republican-appointed justices to rule that the federal exchange subsidies are invalid. Asked if he believes he’d lose the votes of any of the five conservative justices, he smiled and said, ‘Oh, I don’t think so’.”

Must- and Shall-Reads:

• Rhys R. Mendes: The Neutral Rate of Interest in Canada
• Bull Market
• Zeynep Tufecki: “Hah. Slate’s higher-ed columnist says of course she exaggrates, skips on research, simplifies to bring on vitriol” https://t.co/PARzQ6mmEp
• Philippe Legrain: Germany’s Economic Mirage
• George Magnus: Xi Jinping’s Pure Party
  Joseph E. Stiglitz: Europe’s Austerity Zombies
• Laura Tyson: Paying for Productivity

1. David Card and Laura Giuliano: Study by UC Berkeley professor, colleague questions effects of gifted education: “Students with high standardized test scores but relatively lower IQs than their “gifted” counterparts experience the most improvement in their test scores–particularly those from disadvantaged backgrounds who are commonly excluded from gifted and talented programs…. David Card and… Laura Giuliano… one of the only two studies evaluating the effects of gifted education. “Unfortunately, there’s not enough scientific knowledge on how any of these programs work,” Card said… a large, urban district in Florida. Students within the district are admitted to gifted programs, determined by a high IQ score. To fill out empty seats in the gifted class, the district would admit students who scored at the top of their third-grade class in standardized tests. Researchers found that these students improved more in their standardized test scores as a result of enrolling in the gifted class…”

2. Peter Thiel: [Robots Are Our Saviours, Not the Enemy:][1] “Americans today dream less often of feats that computers will help us to accomplish…[and] more and more we have nightmares about computers taking away our jobs…. Fear of replacement is not new…. But… unlike fellow humans of different nationalities, computers are not substitutes for American labour. Men and machines are good at different things. People form plans and make decisions…. Computers… excel at efficient data processing but struggle to make basic judgments that would be simple for any human…. [At] PayPal… we were losing upwards of $10m a month to credit card fraud…. We tried to solve the problem by writing software…. But… after an hour or two, the thieves would catch on and change their tactics to fool our algorithms. Human analysts, however, were not easily fooled…. So we rewrote the software… the computer would flag the most suspicious trans­actions, and human operators would make the final judgment. This kind of man-machine symbiosis enabled PayPal to stay in business…. Computers do not eat…. The alternative to working with computers… is [a world] in which wages decline and prices rise as the whole world competes both to work and to spend. We are our own greatest enemies. Our most important allies are the machines that enable us to do new things…”

3. Charles Evans: Patience Is a Virtue When Normalizing Monetary Policy: “At the end of the second quarter of 2014, the labor force participation rate was between 1/2 and 1-1/4 percentage points below trend… as much as 3/4 of a percentage point below predictions based on its historical relationship with the unemployment rate…. Virtually all the gap during this cycle has been due to withdrawal from the labor market of workers without a college degree…. If skills mismatch were an ongoing problem, we’d expect to see wages rising for those with the skills in demand…. Pools of potential workers other than the short-term unemployed, notably the medium-term unemployed and the involuntary part-time work force, substantially influence wage growth at the state or metropolitan statistical area level…. Current circumstances and a weighing of alternative risks mean that a balanced policy approach calls for being patient in reducing accommodation…. The biggest risk we face today is prematurely engineering restrictive monetary conditions…. If we were to… reduce monetary accommodation too soon, we could find ourselves in the very uncomfortable position of falling back into the ZLB environment…. There are great risks to premature liftoff…. And the costs of being mired in the zero lower bound are simply very large…”

4. Michael Lewis: Occupational Hazards of Working on Wall Street: “Technology entrepreneurship will never have the power to displace big Wall Street banks in the central nervous system of America’s youth, in part because tech entrepreneurship requires the practitioner to have an original idea, or at least to know something about computers, but also because entrepreneurship doesn’t offer the sort of people who wind up at elite universities what a lot of them obviously crave: status certainty…. The question I’ve always had about this army of young people with seemingly endless career options who wind up in finance is: What happens next to them? People like to think they have a ‘character’, and that this character of theirs will endure…. It’s not really so…. The best a person can do… is to choose carefully the environment that will go to work on their characters. One moment this herd of graduates of the nation’s best universities are young people…. The next they are essentially old people… gaming ratings companies… designing securities to fail… [to] make a killing off the… dupe[s]… rigging various markets at the expense of… society… encouraging… people to do stuff with their capital… they never should do…. All occupations have hazards. An occupational hazard of the Internet columnist… is that he becomes the sort of person who says whatever he thinks will get him the most attention rather than what he thinks is true, so often that he forgets the difference. The occupational hazards of Wall Street are… the pressure to pretend to know more than he does… hard to form deep attachments to anything much greater than himself… enormous pressure to not challenge or question existing arrangements…. So watch yourself, because no one else will.”

5. Rhys R. Mendes: The Neutral Rate of Interest in Canada: “A measure of the neutral policy interest rate can be used to gauge the stance of monetary policy. We define the neutral rate as the real policy rate consistent with output at its potential level and inflation equal to target after the effects of all cyclical shocks have dissipated. This is a medium- to longer-run concept of the neutral rate. Under this definition, the neutral rate in Canada is determined by the longer-run forces that influence savings and investment in both the Canadian and global economies. Structural forces have likely reduced the neutral rate by more than a percentage point since the mid-2000s. The Bank’s estimates of the real neutral policy rate currently stand in the 1 to 2 per cent range, or 3 to 4 per cent in nominal terms. The current gap between the policy rate and the neutral rate reflects policy stimulus in response to significant excess supply and in the face of continuing headwinds. As long as these headwinds persist, a policy rate below neutral will be required to maintain inflation sustainably at target.”

Should Be Aware of:

• Austin Frakt: Do falsification tests. (Day of week as an instrument for length of stay

1. Jim Sleeper: For Yale in Singapore, It’s Deja-vu All Over Again: “Once again, the liberal-arts college in Singapore to which Yale has given its name, prestige, energy, and talent finds itself dancing awkwardly with the government over a right that liberal education depends on and should foster: the right to show Pan Tin Tin’s documentary film, “To Singapore With Love,” which criticizes Singapore’s way of turning political and artistic citizens into exiles.”

2. Melissa Bell: Vox’s New Homepage, Explained: “Vox.com has a fancy new homepage…. We’ve built a homepage that’s designed to link together the stories we’ve done over time. If the slots look unusually tall to you, that’s because they are: they’re designed not for one headline, but for many headlines. That way, if something happens in, say, Ukraine, we’re able to offer both our newest story on the topic, but also the stories leading up to today. I’ll be honest: I have no idea if this is going to work. It’ll require a different type of curation and we need to build a robust taxonomy behind the scenes. And even if we get that right, there’s no guarantee that readers will want to consume our stories this way. But if it doesn’t work, we’ll change it…”

3. Ilya Shapiro: Eric Holder: Worst Attorney General Ever :: Cato @ Liberty: “With Eric Holder’s departure, the nation can begin to heal. His was the most divisive tenure of any attorney general I can recall, tearing the country apart on racial and partisan lines. From politicizing Justice Department hiring beyond the wildest accusations against the Bush administration, to running a bizarre guns-to-gangs operation that even Alberto Gonzales couldn’t have concocted, to advocating a racial spoils system at all levels of government, Holder has tarnished the nation’s highest law enforcement office more even than Nixon’s AG John Mitchell. Indeed, the main difference between Holder and Mitchell is that Holder hasn’t gone to jail (yet; the DOJ Inspector General better lock down computer systems lest Holder’s electronic files “disappear”). Of course, Holder has been cited for contempt by the House and referred to a federal prosecutor for his involvement in Fast & Furious – which referral went nowhere due to invocations of executive privilege (sound familiar?). And who knows what role he may have played in the IRS’s targeting of the administration’s political enemies (and even those who merely educate about the Constitution)? Just as bad Holder’s legal violations and contempt for the separation of powers, however, is his racialist view of the world. Like a modern-day George Wallace, Holder has called for racial preference now, racial preferences tomorrow, racial preferences forever. According to our outgoing attorney general, and the 14th Amendment, Civil Rights Act, and Voting Rights Act only protect some citizens (members of the right kinds of racial minority groups) – and should be used to extract political and financial concessions for them. Still, it must be said that Holder was a “uniter not a divider” on one front: under his reign, the Justice Department has suffered a record number of unanimous losses at the Supreme Court. In the last three terms alone, the government has suffered 13 such defeats – a rate double President Clinton’s and triple President Bush’s – in areas of law ranging from criminal procedure to property rights to securities regulation to religious freedom. By not just pushing but breaking through the envelope of plausible legal argument, Attorney General Holder has done his all to expand federal (especially executive) power and contract individual liberty beyond any constitutional recognition. Eric Holder will not be missed by those who support the rule of law.”

David Card and Laura Giuliano: Study by UC Berkeley professor, colleague questions effects of gifted education: “Students with high standardized test scores…

…but relatively lower IQs than their “gifted” counterparts experience the most improvement in their test scores–particularly those from disadvantaged backgrounds who are commonly excluded from gifted and talented programs…. David Card and… Laura Giuliano… one of the only two studies evaluating the effects of gifted education. “Unfortunately, there’s not enough scientific knowledge on how any of these programs work,” Card said… a large, urban district in Florida. Students within the district are admitted to gifted programs, determined by a high IQ score. To fill out empty seats in the gifted class, the district would admit students who scored at the top of their third-grade class in standardized tests. Researchers found that these students improved more in their standardized test scores as a result of enrolling in the gifted class…

The extremely sharp but differently-thinking Peter Thiel:

Peter Theil: Robots Are Our Saviours, Not the Enemy: “Americans today dream less often of feats that computers will help us to accomplish…

…[and] more and more we have nightmares about computers taking away our jobs…. Fear of replacement is not new…. But… unlike fellow humans of different nationalities, computers are not substitutes for American labour. Men and machines are good at different things. People form plans and make decisions…. Computers… excel at efficient data processing but struggle to make basic judgments that would be simple for any human…. [At] PayPal… we were losing upwards of $10m a month to credit card fraud…. We tried to solve the problem by writing software…. But… after an hour or two, the thieves would catch on and change their tactics to fool our algorithms. Human analysts, however, were not easily fooled…. So we rewrote the software… the computer would flag the most suspicious trans­actions, and human operators would make the final judgment. This kind of man-machine symbiosis enabled PayPal to stay in business…. Computers do not eat…. The alternative to working with computers… is [a world] in which wages decline and prices rise as the whole world competes both to work and to spend. We are our own greatest enemies. Our most important allies are the machines that enable us to do new things…

Chicago Federal Reserve Bank President Charles Evans’s position seems to me to be the position that ought to be the center of gravity of the Federal Open Market Committee’s thoughts right now, with wings on all sides of it taking different views as part of a diversified intellectual portfolio. Charles Evans:

Charles Evans: Patience Is a Virtue When Normalizing Monetary Policy: “At the end of the second quarter of 2014…

…the labor force participation rate was between 1/2 and 1-1/4 percentage points below trend… as much as 3/4 of a percentage point below predictions based on its historical relationship with the unemployment rate…. Virtually all the gap during this cycle has been due to withdrawal from the labor market of workers without a college degree…. If skills mismatch were an ongoing problem, we’d expect to see wages rising for those with the skills in demand…. Pools of potential workers other than the short-term unemployed, notably the medium-term unemployed and the involuntary part-time work force, substantially influence wage growth at the state or metropolitan statistical area level…. Current circumstances and a weighing of alternative risks mean that a balanced policy approach calls for being patient in reducing accommodation…. The biggest risk we face today is prematurely engineering restrictive monetary conditions…. If we were to… reduce monetary accommodation too soon, we could find ourselves in the very uncomfortable position of falling back into the ZLB environment…. There are great risks to premature liftoff…. And the costs of being mired in the zero lower bound are simply very large…

Yet Evans is out there on his own–with perhaps Narayana Kocherlakota beside him.[[3]][3]

As I see it:

1. The past decade has demonstrated that to properly reduce the risks of hitting the zero nominal lower bound on safe short-term interest rates, we need not a 5%/year but at least a 6.5%/year business-cycle peak safe short nominal rate.1 With a 3%/year short-term peak real natural interest rate, we need not a 2%/year but a 3.5%/year inflation target instead.

2. It is likely that the safe natural real rate of interest has fallen by 1%-point/year. That means that a healthy economy properly distant from the ZLB requires not a 3.5%/year but a 4.5%/year inflation target.

3. It is very important when the economy hits the zero lower bound on nominal interest rates that expectations be that the time spent at the ZLB will be short. To build those expectations, it is important that when the economy emerges from the ZLB it undergo a period in which the long-run inflation target is overshot.

4. The likelihood is that downward movements in labor force participation that are cementing into structural impediments to employment can be reversed if high demand pulls workers back into the labor force before the cement has set, but only with difficulty otherwise. The benefit-cost analysis thus calls for an additional inflation overshoot in order to satisfy the Federal Reserve’s dual mandate.

5. If the Federal Reserve aims at a 2%/year inflation target and fails to raise interest rates sufficiently early, it may wind up with 4%/year inflation and have to raise short-term real interest rates to 6%/year–a nominal interest rate of 10%/year–to return the economy to its inflation target. If the Federal Reserve prematurely raises interest rates, it may wind up with 0%/year inflation and wish to lower short-term real interest rates to -2%/year to return the economy to its inflation rate. With inflation at 0%/year, it cannot do that. Thus the risks are asymmetric: raising interest rates later than optimal under perfect foresight carries much lower risks than does raising interest rates earlier than optimal.

6. Since 1979 the Federal Reserve has built up enormous credibility as the guardian of price stability and has wrecked whatever credibility it had as the guardian of low unemployment. A situation in which the general expectation is that the Federal Reserve will do too little to guard against high unemployment is worse than a situation in which the general expectations is that the Federal Reserve will too little to guard against inflation–“it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier”.2

7. The PCE price index is now undershooting its pre-2008 trend by fully 5%: the proper optimal-control response to a large negative real demand shock is not a price level track that falls below but rather one that rises above the previously-anticipated trend path.

IMHO, you need to reject all 7 of the above points completely in order to think that the FOMC’s goal of returning inflation to 2%/year and keeping it there is anywhere close to an optimal-control path for an institution governed by its dual mandate. I really do not see how you can reject all seven.

Moreover, financial markets right now believe that the Federal Reserve’s policy is not going to attain 2%/year inflation–not now, not over the next five years. Since June the on-track-to-recovery Confidence Fairy–to the extent that she was present–has flown away:

Thus right now justifying the Federal Reserve’s policy track seems to me to require rejecting all seven of the points above, plus rejecting the financial markets’ read on monetary policy, plus rejecting the consideration that depressed financial markets–even irrationally-depressed financial markets–should be offset with additional demand stimulus.

Yet only two of the seventeen FOMC participants are with me. Am I off my rocker? Have they been consumed by groupthink? How am I to understand all this?

[3]: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf (Percent
Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, September 2014: Advance release of table 1 of the Summary of Economic Projections to be released with the FOMC minutes)

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